Friday, July 27, 2012

Most
Indians experience daily power cuts. Now, voters are realising that
the price of being powerless without electricity, which may be free
yet not available at all, can be quite high. And politicians too are
becoming aware of the high political price for promising electric
power and then failing to meet the growing demand. This is putting a
premium on availability of reliable electricity. I explore the changing
political dynamics over electric power, and look at the prospect of creating new opportunities
for politicians and policy makers to explore new and innovative ways
to reform the electricity sector. A slightly shorter version of the article has been published in the Asian Wall Street Journal, on July 26, 2012, under the title "Power to India's People".The longer version is below.

India
is facing an electricity crisis. This year, five states have declared
power holidays and another eight say they intend to ration power at
peak times. Nationwide, there is a peak shortage of around 12%.

This
isn’t exactly a new problem for India since it’s faced such
shortages in the past few decades, but this time there is a
difference. Voters earlier may have countenanced blackouts, but the
increasing living standards of the past decade have now made them
unwilling to do so. Some state governments are summoning the will for
change, and one in particular has even developed solutions that open
the door for more policy innovation and reform.

For
decades, the political wisdom was to provide electricity at very low
cost to consumers, and often at no cost to farmers. So while one set
of users paid little or nothing, another set usually comprising
primarily of the commercial and industrial users, often paid three to
four times higher. These so-called cross subsidies couldn’t keep up
with politicians’ promises though. The result was a big financial
hole for the power generator or distributor—these days the
latter—which eventually left it unable to supply power.

Voter
agitation about these shortages, as well as recent state election
victories for parties that talk about reforming public services, have
gotten politicians to rethink their tack. The southern state of Tamil
Nadu, in the face of rolling blackouts for 2-6 hours every day,
agreed to hike tariffs for the first time in a decade this year. The
enormity of the situation can perhaps be best appreciated from the
fact that the two major parties in the state haven’t opposed the
construction of the Kundakulam nuclear power plant, despite NGO
protests over it since last year’s Fukushima meltdown in Japan.

Next,
consider Gujarat, which has summoned the political will for a new
creative idea. In the past decade, it has built a parallel
distribution grid, particularly in rural areas, and offered consumers
a unique choice. If farmers opt for the new grid, separating domestic
and agricultural connections, they are assured electricity for 8
hours a day, but at higher tariffs (they can still access the old
grid). Or they could remain on just the old supply network, without
any assurance of supply of electricity, but at the lower price. To
the surprise of many observers, farmers have opted for the former. At
the same time there has been an aggressive steps to curb theft of
electricity.

Tamil
Nadu and Gujarat’s examples clearly show that people prefer stable
supply of power over its price. The ideal next step is complete
deregulation of distribution, but let’s be realistic: Few
politicians will abandon control so quickly; nor will they be brave
enough to immediately take this radical solution to voters. Meantime,
though, state governments can take their innovations to the next
level.

Gujarat’s
case demonstrates that farmers could do with the irregular supply for
some needs such as running household appliances, but for larger
requirements like tending to their fields, they specifically want a
premium supply. Yet, right now, this comes in the form of a
second distribution network, which is expensive
to build and maintain. Increasingly, however, rural households too
are beginning to realise the benefit of assured electric supply, and
many are opting for the new three phase supply, at a higher rates,
which allows them to start small household businesses too. Despite
all these changes, those who want to retain their old connections
based on size of their electric motors, at fixed but low tariff,
without assured supply, are allowed to do so too. This option has
been a very important element in diffusing the political opposition
to increase in tariff.

Vernon
Smith, the Nobel laureate economist had suggested differential
pricing as an economic strategy to overcome political opposition to
increase in tariff using the same grid. One way forward is for
consumers to pay a below-market price for ‘x’ units of
electricity—or, for the poorest households, even make consumption
of these ‘x’ units free. But above ‘x’, electricity should be
priced competitively.

The
'x' could be calculated on the basis of average household consumption
in the past three or five years. Or it could be politically agreed
upon to make a certain minimum amount of electricity as a right
available to all households at a nominal or no cost.

Today, per capita consumption of
electricity in India is one-twentieth of that in the United States.
As India’s economy grows, more
people will begin to enjoy the benefits of many modern appliances,
and consume more electricity, this big marginal increase in
consumption would be paid at market prices. After some years,
most of electricity consumption will be at competitive prices.

Such
a transition will change the landscape of the power industry and make
it more economically viable. It will reduce the incentive for
political interference in pricing, since consumers would be willingly
hiking their electricity consumption and enjoy assured supply,
without expecting to be subsidized. Meanwhile, politicians can still
claim to be pro-poor. Losses incurred by state-owned distribution
companies, which currently runs to over 1 trillion rupees ($ 20
billion) all over India, would dramatically come down.

As
a result, this system would stop skewing price signals. Today’s
distribution network involves below-market prices nearly across the
board, which means that few producers have incentives to set up power
plants. Even in Gujarat, the incentive isn’t fully in place since
one distribution grid still operates on subsidies.

This
plan for a single-grid premium system still involves some
distortions, but that distortion itself dwindles once most
electricity consumption takes place above ‘x’. And this is,
anyway, an intermediate solution to convince voters of the idea of
paying competitive prices for quality supply from utilities they took
for granted a decade ago. A grid that is financially viable will also
allow large consumers and generators to directly negotiate the price
of electricity, and this increased capacity to trade in electricity
which will dramatically improve the financial health of the
generators and assure quality supply to consumers.

Clearly,
innovations like these will not occur overnight, and not across all
states at the same time. But voters are realising that the price of
being powerless without electricity, which may be free yet not
available at all, can be quite high. And politicians too are becoming
aware of the high political price for promising electric power and
then failing to meet the growing demand. So the political trend in
favor of competition is clear, and in a federal setup such as India,
the onus will fall on the states to explore and experiment with such
ideas. When political leaders feel confident that voters are behind
them, these governments will surely begin to take the small steps
leading to bigger reforms in the electricity sector.